Analysis and criticism of America's most prominent public intellectual and champion of Keynesian economics. I am part of the Austrian School of Economics, and I critique Krugman's writings from that perspective.

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Monday, February 14, 2011

Krugman: Welfare is the Nation's "Seed Corn"

Paul Krugman must feel at times as though he is Horatio at the Bridge. He openly campaigned for Democrats last fall only to see the House fall to Republicans and for the Democrats to see their once almost insurmountable Senate majority fall apart. And now, the Republicans are calling for budget cuts and Krugman once again dons his battle gear.

Now, I absolutely agree with him that the military budget should not be sacrosanct, and most likely I would want more cut out of the Budget to Preserve the Empire than would he. (After all, Keynesians believe that military spending also serves as an economic "stimulus," even if they don't like what it accomplishes.) Any Republican who believes that the current level of military spending and military interventions overseas is sustainable is not someone who is willing to listen to reason.

However, Krugman does not seem to be particularly exorcised about the lack of Republican desire to cut military spending. Instead, he decides that a poll by the Pew Research Center really should be the centerpoint of economic policy. He writes:

...Americans were asked whether they favored higher or lower spending in a variety of areas. It turns out that they want more, not less, spending on most things, including education and Medicare. They’re evenly divided about spending on aid to the unemployed and — surprise — defense.

The only thing they clearly want to cut is foreign aid, which most Americans believe, wrongly, accounts for a large share of the federal budget.

Pew also asked people how they would like to see states close their budget deficits. Do they favor cuts in either education or health care, the main expenses states face? No. Do they favor tax increases? No. The only deficit-reduction measure with significant support was cuts in public-employee pensions — and even there the public was evenly divided.

The moral is clear. Republicans don’t have a mandate to cut spending; they have a mandate to repeal the laws of arithmetic.

In other words, since no one really wants to stop spending, let's just pretend that we have lots and lots of money, or that we can increase the national debt or just get the Fed to give us QE3, QE4, and QE5, which is the Going-Out-Of-Business Sale. In the meantime, Krugman really wants us to think that unless we have a vast welfare state, somehow our economy and our society will disappear:

The answer, once you think about it, is obvious: sacrifice the future. Focus the cuts on programs whose benefits aren’t immediate; basically, eat America’s seed corn. There will be a huge price to pay, eventually — but for now, you can keep the base happy.

Yet, if anyone has called for the eating of the economy's seed corn, it has been Paul Krugman. Because, in his view, capital simply "happens," then we don't have to worry about capital development, given that if we spend lots of money, capital magically appears.

To Paul Krugman, there is no difference between real wealth and the printing of money. As he wrote in The Return of Depression Economics, all it takes is for the government to end the downturn is just to print money. There is, he claims, a "free lunch" out there. What he does not say is that these are the very policies that destroy our real seed corn, our capital base.

Krugman misrepresents the findings of the Pew poll, and we really should call him up on it.

The poll merely selected some arbitrary list of items and asked whether people wanted increase, decrease or stay the same. It didn't necessarily represent all the possible items, for example Krugman mentions cutting into the "vast armies of useless bureaucrats" but this poll doesn't even offer such an option.

Similarly, there's an option about changing medicare, but it seems that changes to medicaid are out of the question, regardless of what the people surveyed would like to do. This makes it laughable to say "Republicans have a mandate to repeal the laws of arithmetic" because the laws of arithmetic never even got a chance to apply with this poll.

Beyond that, the poll does not ask how big the increase or decrease should be in each category. It is quite reasonable to want a large cut in one category, enough to deliver modest increases in several other categories. Krugman's accounting is along the lines of counting the number of items in the credit column and then counting the number of items in the debit column and using the percentage to figure out whether the account is in credit or debit. Bit cheeky for someone doing that to lambast others about the laws of arithmetic. Maybe Krugman should take the time out to learn basic arithmetic himself before pretending to be superior to anyone.

Finally, somehow Krugman makes it into a Republican vs Democrat thing, but the poll was never separated out by political party as far as I can figure it. Republicans are under no political pressure to pander to rusted on Democrat voters -- Republicans don't care how unpopular their cuts are amongst Democrat voters, they only care about their base and the swinging voters.

Thanks to the "seed corn" of our public schools, the rabble is so disengaged (and just plain dumb) that they cannot even conceptualize unpayable debt, much less the nature of diluted funny money. Good luck explaining ABCT.

"To Paul Krugman, there is no difference between real wealth and the printing of money. As he wrote in The Return of Depression Economics, all it takes is for the government to end the downturn is just to print money.

It is not the printing of money that lifts an economy out of recession.

And "printing of money" is not even necessary, as money could be borrowed from private markets.

It is government spending that can use idle resources, raise capacity utilization, use idle labour, and enable the private sector to create wealth - just as increased private spending would if money was borrowed privately as well.

If one accepts that money is not wealth, there is still no doubt that spending of money when people demand commodities facilitates creation of wealth by the private sector.

That applies to either private or public spending, especially in an economy with high unemployment, historically low capacity utilization, and idle capital goods.

"If your Austrian rubbish were even remotely true, then even private investment and spending would never lift an economy out of recssion either"

When will whatever-Keynesian idiots ever realise that if Austrian "rubbish" were accepted, we wouldn't have recessions and depressions of the kind that we have been encountering for the last few centuries?

if Austrian "rubbish" were accepted, we wouldn't have recessions and depressions of the kind that we have been encountering for the last few centuries?

Utter nonsense.

An Austrian world of completely free capital accounts and unregulated non-FRB banking would still be perfectly capable of causing asset bubbles and deflationary depressions. Money could come into a country via the capital account and be used in mass speculation on asset prices.

And, moreover, the Austrian anti-FRB position is itself incoherent and would require restriction of free contract and private enterprise - so it turns that out your anti-FRB Austrianism is just another "evil" anti-freedom ideology requiring limits on private liberty.

The only logically consistent Austrians are the pro-FRB and free banking ones - and there is overwhelming empirical evidence from the 19th century that such a system had a business cycle and asset bubbles.

"The only logically consistent Austrians are the pro-FRB and free banking ones - and there is overwhelming empirical evidence from the 19th century that such a system had a business cycle and asset bubbles."

The empirical evidence includes all the different interventions of government in the monetary system such as the imposition of central banks, protection for FRB in the form of repeated suspension of the requirement that banks redeem notes and deposits in specie, restrictions on branch banking, etc. None of these is part of Austrian "rubbish". Got some evidence to demonstrate that it was otherwise?

Please explain the source of the money that flowed into Australia and show that it did not flow from a Central Bank and/or an FRB system protected by government.

A lot of British capital - and that money was not created by the "evil" Bank of England, it was private investment capital - so this trick won't help you.

And anyway, assuming that there were no central banks or FRB anywhere, that would still not stop people pouring their gold into a country where there was some feverish asset bubble - where people think they can make a fast buck.

"A lot of British capital - and that money was not created by the "evil" Bank of England, it was private investment capital - so this trick won't help you."

No tricks there. I just wanted you to confess that it was British money. Incidentally, it is British "money", not British "capital" that flowed in. Britain had a Central Bank called the Bank of England and it also had an FRB system that had the protection of government. Further, Peel's act was passed in 1844 following which there was an explosion in the amount of money created by the British banking system in the from of demand deposits because Peel's Act restricted note issue but failed to restrict emission of demand deposit money. To claim that this money was not created by the BoE-FRB combine is blatant falsehood. That's not surprising considering that whatever-Keynesians are pathological liars.

"And anyway, assuming that there were no central banks or FRB anywhere, that would still not stop people pouring their gold into a country where there was some feverish asset bubble - where people think they can make a fast buck"

The cause of the feverish asset bubble is important. Please demonstrate one example other than the Tulip Mania where gold flowed similarly to fuel an asset bubble. That's because I have an answer for the Tulip Mania.

Do you really teach economics? I need to make sure my children never attend Frostburg.

Krugman calls for the printing of money in Depression Economics in order to cause a predictable inflation. When you have predictable inflation it serves as a disincentive to save all of your money and forces people to spend.

I don't think Krugman wants the government to spend unfettered. Liberals want a balanced budget as much as conservatives. We just believe that we should use higher taxes to pay for the programs we want. Not to speak for Krugman, but personally I think taxes are too low across the board, but are disproportionately low for the wealthy.

1. Human beings can make mistakes. "Government" is still made up of people. Government people just tend to engage in mass slaughter and ordinary "mundanes" do not. Government people do not have special knowledge, and generally have less knowledge and no right to "regulate" third parties. Until there are no people, people will continue to invest in silly, unsustainable enterprises.

2. Re: FRB. Nobody can initiate force on third parties who feel like engaging in a form of FRB. I don't have a problem per se with FRB if it's simply one of many free market money options AND THE RISKS ARE CLEARLY EXPLAINED TO THE PARTICIPANTS AND THOSE ACCEPTING NOTES AND CHECKS drawn on such accounts. If one is notified of the risks, there can't be fraud because there has been no mispresentation. But I doubt any private entity is going to want to provide deposit insurance at reasonable rates for such an enterprise. But that's up to the participants. The key point is that people are not misled into thinking that a check on an FRB account is the same thing as a check drawn on a 100% reserve account. If one is so misled, I say that is fraud.

Of course people want greater spending in certain areas. I wouldn't mind an increase in California's education budget, but that's because I benefit directly from that kind of subsidy. Otherwise, I wouldn't mind a wage hike for California high school teachers, since I benefit indirectly from that kind of subsidy (my dad is a high school teacher).

Wealth redistribution shouldn't be legitimized by whether or not people want it to occur. Everyone likes free money. They should be justified by whether or not they actually accomplish a net gain in societal welfare. With that said, obviously I think there is a strong case for believing that these subsidies do not accomplish a long term rise in societal wellbeing.

By the way, regarding free banking and periods of history without central banks, I (again) suggest actually reading the bevy of free banking literature on the subject. Any free banker will tell you that there hardly has been a period in history of real free banking, with Scotland usually being considered the closest thing to it. Regarding the United States, I think there is some division. For example, I believe that Selgin, White, and Dowd consider the American "free banking" era as less of an example of free banking as the Scotland example, while I believe Larry Sechrest argues the opposite.

The overall lesson, though, is that a lack of a central bank does not mean a lack of regulation, and even doesn't really speak for whether or not there is a currency monopoly.

I don't see why inbound foreign currency could cause malinvestment, within the Austrian macro/micro framework. The Austrian boom/bust theory is one of severe intertemporal discoordination, caused mainly by substantial rises in the supply of loanable funds, and I don't see why an increase in foreign currency could cause this.

It's exactly because foreign currency usually can't find a prolonged market in foreign countries that there is a theory that suggests that all currency traded to foreign countries tends to return, exactly because the goods which trade in that currency are those built in the area where that currency is traded (when a currency is exchanged for a foreign good, what you are really exchanging for is the local currency of that good, and then the good).

However, I agree that free fractional reserve banking is more theoretically sound than anti-fractional reserve free banking. We could debate this for millenia; hopefully, I'm preparing an article that clarifies the free banker's position. However, in the event of healthy economic activity, the activities of a bank under Selgin's model probably would not be too different from that under Rothbard's model, since empirically it's been shown that the demand for money doesn't change dramatically. The major difference is whether or not banks could get rid of gold reserves when demand for outside money falls.

" "Capital" in the sense of money is a widely accepted use of the word. I love to see you try and refute the Oxford English Dictionary. "

It takes a really special idiot to confuse meanings as in the Oxford English Dictionary with the DEFINITION of a term as used in economics. In ECONOMICS, which I expect you are unfamiliar with, money is NOT the same as capital. Money, which is basically a medium of exchange, also acts as one form of capital. Capital takes many other forms which whatever-Keynesians are too idiotic to understand.

So, it is not about "refuting" the OED but stating that the meaning as in OED is not exactly the one applicable in a study of ECONOMICS, you economic chronicler.

"And, as I said, the money that could easily flow into a country under any anti-FRB Austrian system would easily inflate asset prices."

That theoretical possibility does not take away from the fact that your much touted Australian depression was caused by Central Banking+government protected FRB in Britain. It is really hilarious to watch you trying (rather laughably unsuccessfully) trying to deny it.

"The main point above - that anti-FRB Austrianism is totally inconsistent with economic liberty and free contract - totally destroys this Austrian fanasty"

That's the main non-point. It does not matter whether one agrees with or disagrees with FRB. It is simply that Central Banking+FRB has been the CENTRAL cause of the business cycle all throughout the last 3 centuries.

Only pathological liars and whatever-Keynesians (actually the same category) will deny that. And you are just proof of my statement.

If Austrian Economics is baloney, why do Anderson and Murphy keep getting it right and Krugman keeps getting it wrong? Moreover, Anderson and Murphy's forecasts come true. Krugmancan't even figure out why he was wrong, even ex post.

And I suppose Krugmans Nobel Prize in Economics is proof of just how wrong he has gotten it. Thank god Anderson and Murphy don't have that shameful bling to tarnish their resume's.

I can't believe 300 years later people still seem to think that laissez-faire is a good idea. Even Adam Smith called for government regulations. I honestly can't believe I am even having this argument. I guess my advise would be to not go to close to the horizon, you might fall off the edge of the world.

This month, the American Economic Review (specifically Kenneth J. Arrow, B. Douglas Bernheim, Martin S. Feldstein, Daniel L. McFadden, James M. Poterba, and Robert M. Solow) named its top 20 articles of the last 100 years. Included therein was:

Back in 1974, Friedrich Hayek won the same Nobel Prize that Krugman recently won. Hayek won it for his work on Austrian theory which basically holds that the boom/bust cycle is caused by Krugmanite policies. So, the Nobel Prize proves nothing except that one needs to treat the ideas of the winners seriously if you are going to disagree with them.

You are one a vast army of people who just know they disagree with the Austrian School and haven't the slightest familiarity with any its basic concepts. Your anti-intellectualism is running wild.

"Kevin said:And I suppose Krugmans Nobel Prize in Economics is proof of just how wrong he has gotten it."Krugman was not awarded the Nobel Prize in Economics for always being wrong. It was for other scholarly work that deemed to be insightful. However, none of his recent predictions have come true - he has been batting zero for a long time.

Correct me if I'm wrong, but didn't Hayek win the prize for his work on the Austrian Business Cycle Theory while Krugman won the prize for his old work on trade theory which has nothing to do with his present Krugmanite version of Keynensian money printing and massive debt?

"Lord Keynes is actually correct. Mises is also very clear about what "capital" is."

However, if it was indeed capital as LK says, what you said in your other post

"The Austrian boom/bust theory is one of severe intertemporal discoordination, caused mainly by substantial rises in the supply of loanable funds, and I don't see why an increase in foreign currency could cause this."

raises a further question. Can a substantial rise in the supply of foreign capital cause malinvestment and the boom-bust cycle? Given that, if one were to take LK's statement as correct, it was British capital that drove the asset bubble in Australia leading to the depression of 1893, can one not say that after all the credit expansion happening in Britain from 1844 to 1893 under the BoE+FRB system was also responsible for capital flows to Australia and hence that it fuelled the malinvestment out there? Can I not say that these capital inflows increased the supply of loanable funds in the Australian economy and thus make my explanation consistent with the Austrian theory of the Business Cycle?

All I would like to understand is what caused the Australian depression of 1893. LK claims it is just free-banking gone wild. My contention is that it is not so and that his point about massive inflows of British capital, emanating as it does from a system of Central Banking+FRB actually justifies my position.

I would definitely appreciate any time you would take out to explain which position is right and lead me to an Austrian analysis of the Australian Depression of 1893.

Just thought I'll give better shape to my question since your answer is indeed important for my understanding.

I am repeating below the entire Mises Wiki on the Australian Banking Crisis of 1893.

"The 1893 banking crisis occurred in Australia when several of the commercial banks of the colonies within Australia collapsed.During the 1880s there was a speculative boom in the Australian property market. Australian banks were operating in a free banking system, in addition to few legal restrictions on the operation of banks, there was no central bank and no government-provided deposit guarantees. The commercial banks lent heavily, but following the asset price collapse of 1888, companies that had borrowed money started to declare bankruptcy. The full banking crisis became apparent when the Federal Bank failed on 30 January 1893. By 17 May, 11 commercial banks had suspended trading."

My main question is this - What caused the speculative boom of the 1880's? Could a massive inflow of British capital have caused it? Did it? If so, can we say that even though Australia was under free-banking, the Central Bank+FRB system of Great Britain created the speculative boom in Australia in the 1880's?

I just hope you answer this because LK has been talking of the Australian Crisis of 1893 for quite some time as a refutation of ABCT. I would like to see someone of your knowledge and understanding answer this question.

You mean the same journal that Krugman was recognized in for having one of the top 20 articles?

You know there is a reason why Austrian economics is outside the mainstream. It doesn't have anything to back it up. Real economics (read Keynesian) is built on the foundation of real Mathematical models. I know that most Austrian economists lack basic math skills, and have no appreciation for the scientific method, but that is no reason to take your anger out on real Economists like Krugman who actually know what a function is.

Perhaps you should spend more time practicing your arithmetic so you can understand what real economics is and less time bashing Krugman.

"You know there is a reason why Austrian economics is outside the mainstream. It doesn't have anything to back it up. Real economics (read Keynesian) is built on the foundation of real Mathematical models."

Thanks for revealing that your definition of Economics is different from that of Austrians. People like me consider all your dabbling with numbers as either Economic Chronicling or Economic Gobbledygook as we fail to see any rationale to the basis of these models.

Please explain the basis of these models and why they constitute a part of Economics.

"I know that most Austrian economists lack basic math skills, and have no appreciation for the scientific method,"

Assumptions... Assumptions.... That apart, how did you come to the conclusion that the "scientific method" is the most appropriate one to apply to the study of Economics? What IS the appropriate methodology of Economics? Please highlight your methodology so that we could debate whose methodology makes more sense.

"but that is no reason to take your anger out on real Economists like Krugman who actually know what a function is."

Oh!! A "real" economist has to know what a function is because the proper method of Economics is mathematical modelling. But then that is precisely the justification I have asked for a few lines above. So, please answer that question before your claims that Krugman is a "real" economist can be taken seriously.

I'm not at home, so I can't conduct any research of my own at this point. Usually, the relevant currency in local investment is the local currency. For example, the relevant currency in the United States tends to be the dollar, because that's the medium of exchange used in the United States. So, let's say there is an increase in Chinese interest in investment. The Chinese would have to first buy dollars, then invest (or, this could be done indirectly, but the concept is the same). We can see that the relevant currency is the dollar, and only through a disequilibrating increase in dollars can there be intertemporal discoordination.

I don't know what the currency situation was in Australia and Britain at the time. I would have to do research.

However, I'm sure that the foreign capital inflow argument doesn't apply to several situations where it has been applied to. For example, Argentina's financial crisis in the early 90s was not caused by neoliberalism, or an increase in foreign investment, but by irresponsible Argentine central bank policy.

With regards to 19th century Australian free banking, there's a number of critical points. Most significantly, Australia was a penal colony at the time and so a large percentage of the population were either prisoners or soldiers. Neither of these groups of people were exactly "free" to trade or go about their regular business -- the troops were under orders and the convicts were wearing chains.

That said, convicts were allowed to own money and many of them did bring small amounts of money from England. When sentenced to transportation, their loved ones generally never expected to see them again, so they gave them what they could.

The Bank of New South Wales was private, but a "private" incorporation in the 19th century had a bit of a difference meaning to what it does today. Governor Macquarie issued the charter of incorporation in the name of the British Crown (although it is arguable whether he had the authority to do so, he did have loyal troops on the ground), without assent and support of the governor there would have been no Bank of New South Wales.

The BoNSW did issue paper money, which circulated successfully, but paper money was already circulating in many forms in the early colony including private promissory notes, paymaster notes issued as pay to troops and Commissariat store receipts (redeemable for goods at the central government store).

In addition, new convicts who brought coins from England were strongly encouraged to deposit those coins into the BoNSW (such a deposit was in theory voluntary but was pushed by the government powers at the time, which were considerable when you were a prisoner).

Beyond that, Governor Macquarie strongly disliked the trading of alcohol (rum in particular) as a local currency, and his support of the BoNSW was inspired by a morality drive and his own social engineering projects (which were not inconsiderable).

When the gold rush came through, the BoNSW bought gold in exchange for paper notes, inflation was inevitable under these circumstances and of course there came a day when the gold stopped coming. Soon after the gold rush, Australia suffered strikes from workers who figured their goldrush-inflated wages should become permanent.

1893 was a bad year for banking in Australia, but 1890 had seen major maritime strike action, 1891 saw the big shearers strike and inevitably these events caused significant business losses, which cascaded into bank losses.

Until there are no people, people will continue to invest in silly, unsustainable enterprises.

Very true, and early Australia had a bunch of smaller private banks, many of which did go broke. However, the BoNSW was the largest and with the most support from central government, and it certainly did make a practice of issuing paper money without 100% reserve in any material commodity, right from the get-go. The BoNSW continues today under the name of Westpac and I believe it is still our biggest bank (or very close to it).

I would argue that any economic system must deal with banks going broke from time to time, and support an orderly procedure for that.

Most significantly, Australia was a penal colony at the time and so a large percentage of the population were either prisoners or soldiers.

At what time?? Certainly not in teh 1880s or 1890s.Your history of Australia is flawed: by the 1860s and 1870s 100 000s of free settlers had come to Australia, overwheling the convict population.

All the states had long since ceased to be penal colonies:

Transportation to the colony of New South Wales was finally officially abolished on 1 October 1850.

Transportation to Tasmania ended in 1853

The last convicts to be transported to Australia arrived in Western Australia in 1868.

http://en.wikipedia.org/wiki/Convicts_in_Australia

When the gold rush came through, the BoNSW bought gold in exchange for paper notes, inflation was inevitable under these circumstances and of course there came a day when the gold stopped coming

So asset bubbles can happen under a gold standard too?

1893 was a bad year for banking in Australia, but 1890 had seen major maritime strike action, 1891 saw the big shearers strike and inevitably these events caused significant business losses, which cascaded into bank losses.

The cause of the depression of 1890s was a bursting asset bubble in property, bank runs, and debt deflation.

LK, the BoNSW was established in 1816, and had happily been issuing script for the best part of a century before the 1890 crash. More than that, it was backed on a number of occasions by the NSW government, such as when they tried to introduce Spanish Dollars as a substitute for British Pounds, then later punched the center out of those to make "holey dollars" which are now the symbol of the modern Macquarie Bank. At the time, the colony was very short of circulating currency.

You can also find "police fund" notes issued in British Pound denominations which were government issue script (and backed by the fees, fines, duties, etc that police could collect) -- these were used as pay, and I believe the function was eventually also rolled into the BoNSW.

So asset bubbles can happen under a gold standard too?

I would have thought it was simple supply and demand that when a whole bunch of new gold is discovered, all the existing gold devalues. At any rate, using commodities to back a currency works better with a spread than with any single commodity, but as a general rule massive influx of any new commodity is a rare and unusual event (especially gold).

There is always the possibility of external disruption in any system. Massive plague may halve the population in a decade. I think its a better measure to see how quickly the system rights itself after a disruption, and whether it topples over without any external disruption.

To be fair, the USA is currently being disrupted by the rising demand for oil and the falling price of manufactured goods (as the manufacturing industry becomes ever more cut-throat). These are extrinsic factors forcing the US economy to be less competitive in an international market. Worse than that, the US technological lead is shrinking, and the boon that FDR achieved by his excellent playing of WWII has largely faded.

However, the current US banking system is having a devil of a time adjusting to these factors, and the US government has its head stuck under a blanket.

3. Bob Murphy has a PhD from NYU. That's not an Austrian program. He can do the math.

Math is simply not applicable to praxeology. Since "critics" who attack (and just fling insults at) the Austrian School for not using math haven't the slightest familiarity with praxeology or basic Austrian concepts, they should just be ignored.

4. LK admits that FRB is a recipe for disaster unless it is "tightly regulated", whatever that means. Since the gist of the ABCT is people being misled by the nature of funny money or pre-Fed FRB, I see people being misled by FRB in general due to thinking that their deposits or bank notes are the same as those backed by 100% reserves. In any event, FRB would have to be "regulated" by the participants so that both they and third parties who deal with them are not misled into thinking this is a different animal than what it is.

5. LK has a paper about Australia in the 1890s which he hasn't shared and which costs $30. Also, since LK is clueless about basic Austrian concepts, he's failed to share important facts from his paper that would help us understand what he's really saying. Since he admits there wasn't a 100% reserve requirement, I don't see how the episode is particularly relevant anyway.

Anyone who has spent any time applying economic theory to real world behavior (certainly not any of these Keynesian fools) knows that you can't plug human behavior into a statistical model and obtain a reasonably predictable result.

Can anyone explain to me how it is not fraud for a bank to tell all of their customers that they can withdraw all of their money anytime (obviously I am not referring to things like CDs which carry a penalty for early withdraw)? Isn't this really the crux of the problem with fractional reserve banking?

It is not fraud because banks simply are not in the business of lending out money which has been deposited with them. Deposits don't make loans. Loans make deposits.

Banks are "manufactories of credit". What they do is exchange their liabilities - bank money - for the liabilities of people who come to them for a loan, and make money off the spread. They turn your IOU - for a mortgage say - into bank dollars accepted everywhere. State policies like acceptance of bank money for taxes, discount window lending from the Fed and deposit insurance make bank money as good as dollar bills in the economy. So seen, what they do is credit farming of the state's money, comparable to tax farming of the state's tax impositions in the past.

"The cause of the depression of 1890s was a bursting asset bubble in property, bank runs, and debt deflation"

Incorrect. The proximate cause was a bursting asset bubble in property. That in turn caused bank runs and debt deflation. All this, however, does not answer a very fundamental question - Why did the asset bubble happen and then burst?

I suspect you would say the gold rush caused it and then the cessation of the rush caused it to burst. That may be true, but that still does not answer the question completely. You still need to answer the question "What caused the gold rush?".

A gold rush happens from place A to place B. It is not a "causeless" event that just happens. It is an effect of conscious human action. Gold rushes happen because of the peculiar set of conditions occurring in place A and place B. What were those peculiar conditions that occurred in Britain (the source) and Australia (the sink) at that time? Why did British capital move into Australia?

This is especially important to understand if Australia did not have a Central Bank and had a relatively free-banking system (I am not yet accounting for the government intervention that Tel has spoken of). In that case, it becomes necessary to see the British and Australian economies together because it is possible that the Australian condition is an outcome of the action of British banks, Central Banks and Government.

This, I suspect is part of what JMFC mentioned, not just what you replied with. That is just a small piece in the puzzle. So please explain the causes of the gold rush.

"It is not fraud because banks simply are not in the business of lending out money which has been deposited with them. Deposits don't make loans. Loans make deposits."

When you tell your regular depositors that you can withdraw all of your money at anytime and when in reality a bank run would result, that sounds like lying to to benefit which typically is known as fraud.

It wouldn't be fraud if they were lending money that belonged to them or if the bank and the depositor had some sort of agreement (like when you purchase a cd).

But that is not the case with todays banking.

And when the government says they will insure your deposits in the event of something bad happening (like a run on the bank) it is just encouraging moral hazard. At least that is how I see it.

I don't think this "FRB is fraud" argument will take you too far. You will get unnecessarily entangled in pointless arguments. The problem in your position is that any call for compulsory 100% reserve requirement or declaration of reserve ratios is a violation of the liberty of the banker and probably of the customer as well. That would contradict your otherwise libertarian position.

You have, however, correctly identified deposit insurance as one of the important problems to be tackled. IMHO. That the deposit insurance is offered by a quasi-government entity such as the FDIC in the US is telling. We have an equivalent in India called the DICGC - The Deposit Insurance and Credit Guarantee Corporation, an entity wholly owned by the RBI, the central bank of India.

What you are missing out is another important component that lends stability to an otherwise unstable banking system - the machinery of oppression that government possesses and unleashes on its population in the name of taxation. I'll give you an example. Out here in India, there are severe restrictions on how much cash you can withdraw from your bank account. If you withdraw large amounts of cash for whatever reasons, your bank will intimate the tax authorities and you will be on their radar screens for quite some time. All this is done in the name of preventing tax evasion because cash transactions enable one to hide income and thus pay less tax.

In addition to the above, the Government of India repeatedly and frequently sends out threatening messages on various popular television and radio networks that the Income Tax Department is monitoring all high value purchases, be it cars, televisions, home appliances, land, etc. They actually do it. The aim, once again, is to reduce the number of cash transactions because that would improve tax collections.

To add to all this, banks provide ever easier means of making payments. Debit Cards and Credit Cards have greatly reduced the requirement of actual cash.

The effect has been that people at large have started keeping more and more of their money in the bank. It's "easier" and hassle-free (meaning Big Brother will not trouble you).

All I am saying is that it is a very complex web out there and that untangling it is not going to be very easy. IMHO, the really crucial pillars of the modern banking system are the government machinery of taxation and the deposit insurance system. The former forces people into the banking system and the latter reduces the chance that they get out.

FRB might happen even on a free market. However, a free market would place its own restrictions on FRB. What the government does with the interventions I have cited above is to make the free market forces identified above inoperable. The banking system is thus unleashed to create money with gay abandon. Therefore, IMHO, the real fight should be against these government interventions and not against FRB as such. Railing against FRB would be like missing the woods for the trees.

When you tell your regular depositors that you can withdraw all of your money at anytime and when in reality a bank run would result, that sounds like lying to to benefit which typically is known as fraud.

All the depositors withdrawing their money is not something that would result in a bank run, it is a bank run. As long as the bank is run honestly (good luck finding one nowadays!) its outstanding loans and assets are good, it is solvent and if there is a crazy, unfounded bank run, a liquidity crisis, it can borrow the dollar bills / reserves at the Fed's discount window if necessary. That is (was) one of the purposes of the Fed - so that bad banks don't drag down good ones in panics.

It isn't fraud because banks have the right to create bank money = bank IOUs. That is what you get when you exchange dollar bills (government IOUs) for a bank deposit. Mike Cheel or AA can do that too, people can give us dollar bills and we can give them nice, legal IOUs. Some reasons that people do this without a thought and accept bank IOUs, but not Mike or AA IOUs - are that the government in several ways says bank IOUs are as good as dollar bills: it accepts them for taxes, it insures them, and it gives banks and only banks access to the discount window.

You are right that the government backing of private banks can encourage moral hazard - which is why banks - bank lending - bank money creation - should be strictly regulated. The current crisis is partly due to abandonment and nonenforcement of regulation. More publicly owned state or federal banks to help keep the private ones in line would be a very good idea. (Like the Bank of North Dakota.) Boring, safe, small banking and financial sectors leads to prosperous real economies.

The Rothbardian/other Austrian opposition to FRB is based on a blatant misunderstanding of the legal nature of FRB.

When a FR bank takes money for a new deposit, this is actually a personal loan to the bank, which is why the bank pays interest for it. The money in the deposit becomes the property of the bank. The money is a loan, or legally a mutuum, which means “a contract under which a thing is lent which is to be consumed and therefore is to be returned in kind” (the modern sense of the English word “deposit” is thus misleading when it refers to money in fractional reserve banking). The depositor who lends the money gets a credit (or IOU) from the bank and a promise to pay interest: “the very essence of banking is to receive money as a [m]utuum” (MacLeod 1902: 318). The money has been “sold” to the bank as a mutuum and is to be returned in genere (“in general form”), which means you do not necessarily get the same money back, but just an equivalent amount with interest.In demand deposits, you have lost your absolute property rights to the money when you lent it to the bank, and instead have entered into a contract with the bank to allow them to use it, even though they are obliged to return to you on demand money to the same amount in whole or in part from their other reserves and deposits

"You are right that the government backing of private banks can encourage moral hazard - which is why banks - bank lending - bank money creation - should be strictly regulated. The current crisis is partly due to abandonment and nonenforcement of regulation"

Aaahhhhh!! There comes the socialist/interventionist agenda. Ever thought of what gets "bank money" acceptance as "money" in the first place? Is what you call "bank money" money in the first place? What is "money" and how does "money" get to be "money"?

More than the fraudulent nature of FRB, the key issue is the stability or rather the inherent instability of the FRB system in the absence of systematic and sustained intervention on its behalf by government. My point is simply that but for government intervention to protect the FRB system from its own inherent instability, the free market would have held FRB in check.

You are right that the government backing of private banks can encourage moral hazard - which is why banks - bank lending - bank money creation - should be strictly regulated. The current crisis is partly due to abandonment and nonenforcement of regulation.

Absolutely correct.

Ever thought of what gets "bank money" acceptance as "money" in the first place?

The free market - that is how FRB arose.

Is what you call "bank money" money in the first place??

A thing that can act as

(1) a unit of account, (2) a medium of exchange (3) a store of value(4) a thing that can be used to discharge one’s obligations.

FRB demand deposits or IOUs fulfill the definition of money, without any doubt, and have done so historically for over 2 centuries.

By the same argument "life insurance can easily be seen as equally fraudulent. There are clearly circumstances ... in which too many people would die at one time for an insurance company to pay all of the claims coming in."

the key issue is the stability or rather the inherent instability of the FRB system in the absence of systematic and sustained intervention on its behalf by government.

Virtually ALL business investment or insurance or financial market speculation can be "inherent instable" - because the future is uncertain.

The insurance industry - just like FRB - can be operated profitably over long periods and is stable.

But when some unforeseen disaster happens (a massive natural diaster) the insurance companies would be overwhelmed by claims and collapse, because they cannot pay.

Is that an even REMOTELY serious argument against insurance?

And so too:FRB might be stable over long periods. But when some unforeseen disaster happens (a collapse in export demand, rumours about some bank, a change in subjective business expectations) the FRB system might be overwhelmed by bank runs and collapse, because they cannot pay.

Is that an even REMOTELY serious argument against violating free contract and economic liberty by restricting FRB?

LK wrote:"When a FR bank takes money for a new deposit, this is actually a personal loan to the bank, which is why the bank pays interest for it. The money in the deposit becomes the property of the bank. The money is a loan, or legally a mutuum, which means “a contract under which a thing is lent which is to be consumed and therefore is to be returned in kind” (the modern sense of the English word “deposit” is thus misleading when it refers to money in fractional reserve banking). The depositor who lends the money gets a credit (or IOU) from the bank and a promise to pay interest: “the very essence of banking is to receive money as a [m]utuum” (MacLeod 1902: 318). The money has been “sold” to the bank as a mutuum and is to be returned in genere (“in general form”), which means you do not necessarily get the same money back, but just an equivalent amount with interest."

You are confusing the mutuum contract with the "Irregular" Deposit contract (depositum in Latin).

The two contracts are very much different. The mutuum contract which you fallacious asssociate with the depositum has a component which does not exist with demand deposits:

How long ago? De Soto cites the differences between mutuum and deposit contracts back to Roman Law, specifically, in section 3 of book 16 of the Digest written by Ulpian (Roman classical jurist).

FRB is indeed a departure of traditional legal principles. Ever wonder who agitated for central banks and lenders of last resort? Bankers. They stood to gain substantil illegitamate profits from lending out the depositum.

THe appartus of compulsion and coercion (government) creates these central banks because besides the bankers they have just as much to gain from being the first to get access to miappropriated funds.

This is so irritating. I posted a really really long reply to LK only to find it vanishing.... I just don't have the heart to type it out again.

I'll just summarise by calling LK a liar and an ignoramus.

He does not know what money is. He does not even know what a free market is. He does not know that only a medium of exchange that arises out of a free market can really be called "money". He has no clue as to what FRB is. He does not understand that the insurance industry's risk is EXTERNAL while FRB's is INTERNAL. He has no clue to ABCT and hence does not understand that FRB CREATES the business cycle, thus paving the way for its own downfall.

If all or a very large number of the policy-holders of an insurance company suddenly needed insurance payments over a brief period, the company would collapse.

The insurance companies rely on people not needing to do that - and indeed most of the time it does not happen - just as a FRB relies on the fact that it is highly unlikely that all the FR clients will need their deposits back at the same time - same internal risk.

The whole anti-FRB school argument collapses - and serious Austrians like Gene Callahan have called you on your BS.

"The whole anti-FRB school argument collapses - and serious Austrians like Gene Callahan have called you on your BS."

In case you read what I have written, you will realise that I do not have an anti-FRB argument. I only said that the FRB system is INTERNALLY unstable.

"If all or a very large number of the policy-holders of an insurance company suddenly needed insurance payments over a brief period, the company would collapse."

I do understand this. What you are failing to understand is that such an even is not CAUSED by the actions of the insurance company. Further, such an event is typically what we call a natural or man-made disaster which is truly unexpected. The insurance company does not go around creating the circumstances that lead to a surge in claims.

That is not true in the case of FRB. The FRB system CREATES the business cycle which is the cause of its own inevitable downfall. This is the reason i said that it is INTERNALLY unstable. No external factors cause an FRB system to fail. The FRB system, by being an FRB system, causes itself to fail. It does whatever it takes to create a surge in claims and bring about its own bankruptcy. By engaging in its own business, it makes itself unstable.

You just demonstrated once again that you just do not understand ABCT.

A sudden surge in claims on an insurance company CANNOT BE anticipated by the company at the time of issuing policies.

In contrast, an FRB system knows perfectly well that expanding credit by inflating the supply of fiduciary media (creating bank "money" as you like to call it) will INEVITABLY create a surge in claims for redemption in specie. The surge CAN BE anticipated at the time of engaging in expanding credit, inflating money supply and creating the business cycle. The only knowledge required is that of ABCT.

In contrast, an FRB system knows perfectly well that expanding credit by inflating the supply of fiduciary media ... will INEVITABLY create a surge in claims for redemption in specie

The issue is whether they can meet demand from their FR depositors out of reserves and sale of financial assets - without a liquidity crisis. And the free banking Austrians show that FR banks can do that frequently perfectly well.

"I don't think this "FRB is fraud" argument will take you too far. You will get unnecessarily entangled in pointless arguments. The problem in your position is that any call for compulsory 100% reserve requirement or declaration of reserve ratios is a violation of the liberty of the banker and probably of the customer as well. That would contradict your otherwise libertarian position."

I understand that pointless arguments will begin as there are a lot of central bank cultists in this blog space.

All I am asking is that the banks be honest (lol). If they are not going to be able to give me my money on demand (without a previous understanding \ agreement) then they should not promise that it is the case. I believe creating money with no real reserve behind it is fraud as well. IOU or not. I believe that destroying my savings by issuing money with nothing to convert to on demand is also fraud (as it results in the loss of my purchasing power).

"The issue is whether they can meet demand from their FR depositors out of reserves and sale of financial assets - without a liquidity crisis. And the free banking Austrians show that FR banks can do that frequently perfectly well."

Your statement is patently false. Please tell me why the FRB system had to be repeatedly saved all through the 19th century through government intervention in the form of suspension of the obligation to redeem notes and deposits in specie.

"The issue is whether they can meet demand from their FR depositors out of reserves and sale of financial assets - without a liquidity crisis. "

This statement is all the more false in the 19th century when FRB became dominant thanks to government patronage directly and through the institution of Central Banks. Bank money then represented a promise to redeem notes and deposits in specie. Given the extent of pyramiding on notes and deposits on the existing base of reserves and actual specie available, it was clearly IMPOSSIBLE for these banks to meet their obligations by using their reserves or by selling their financial assets. That's why they needed the support of government in the form of suspension of the obligation to redeem notes and deposits in specie the first place.

I think that these FRB debates are boring, pointless and truly beside the point. The debate will not refute basic Austrian principles of acting man, subjective value and economic calculation or refute our claim that the current system is criminal and the cause of our problems.

The debate is merely about whether or not some future group of unnamed people will or will not be misled by the practices of a private, unsubsidized business. I think there is that strong possibility but the result will probably depend upon the sophistication and morality of the participants and third parties that deal with them.

It's almost like trying to predict all draft choices of the Detroit Lions for the next five years and predicting which ones will make the team and/or be stars. And then predicting the team record five years hence.

Yawn.

Finally, I still fail to see how a bank is so special that it can loan out for interest funds that it really does not have. Why can't I do that?

Also, to me, the gist of the Austrian theory is that the loaning of money created out of nothing makes EVERYONE tend to think that they AND society are wealthier than they really are. Nevertheless, the society will still only contain the same people skills and other resources as existed before the new money was created. That's a recipe for disaster. Actually, society will find itself poorer for malinvesting resources induced by the new money. It's also the point that Austrian critics never seem to grasp.

@Bala:Ever thought of what gets "bank money" acceptance as "money" in the first place? Is what you call "bank money" money in the first place? What is "money" and how does "money" get to be "money"?

Odd first question. I gave 3 reasons why bank money is accepted as money. Yes, bank money is money to nearly all intents and purposes nowadays. It is not money to a bank, because they need a higher level money, reserves=dollar bills to settle their accounts with each other and the Fed.

Money always and everywhere is a form of credit/debt relationship. When credits/debts become transferrable, they become money. This, the usage of money, has only ever occurred on a large scale by government/religious institution involvement.

@Bob Roddis:Finally, I still fail to see how a bank is so special that it can loan out for interest funds that it really does not have. Why can't I do that?

You can do that, if someone trusts you. (Anyone can create money, as Hyman Minsky was fond of saying.) Just get someone to give you their IOU and you give them your IOU. The thing is, bank IOUs are acceptable forms of payment in the general economy, and unless you are Warren Buffett, your IOUs aren't. If they need to, say you want your loaned money in a suitcase, banks in the USA can borrow reserves from other banks or at the discount window from the Fed. They give the other banks or the Fed IOUs, and in return get dollar bills=reserves= Uncle Sam IOUs, to give to you . They are then just intermediaries for a loan from Uncle Sam. Simple as that.

"There has been a criticism of frb based on ethical ideals, but the crux of the "Rothbardian" argument against fractional reserve banking is NOT ethical"

I've been trying for months to get LK to address this point. Even on this thread, that's all I am trying to do, but you can see how steadfast he is in evading that discussion. His laughable insurance analogy is just one more attempt at evasion, but there it is. All he does is evade.

Thanks anyway for making this point. I hope at least after YOU have said it, LK will really try to address it.

There has been a criticism of frb based on ethical ideals, but the crux of the "Rothbardian" argument against fractional reserve banking is NOT ethical.

Rothbard opposes FRB because he thinks it is "fraudulent", though - yes - of course he has some other practical arguments based on the fact that at any one time a FRB could not honour all its contracts to its customers by paying them their money - just like an damn insurance company.

Rothbard's position is still basically a moral argument, pure and simple.

"Rothbard's position is still basically a moral argument, pure and simple."

FALSE.

While Rothbard did give a moral argument, he made it explicit that his primary argument is ECONOMIC. It is simply that FRB causes the business cycle and that very business cycle creates the conditions that cause the FRB system to be unstable.

Your analogy with the insurance industry is BLATANTLY FALSE as the insurance industry is unstable not BECAUSE it conducts its operations the way it does but IN SPITE OF it. On the other hand, the FRB system is unstable BECAUSE OF the way it conducts its business and not IN SPITE OF it. The causes of the failure of an insurance firm are EXOGENOUS to it while the causes of failure of the FRB system are ENDOGENOUS to it. The insurance industry is unstable in the short run because a random, unpredictable disaster of sufficiently large magnitude can bring a firm down but stable in the long-run because it can mitigate the losses through profits it makes in the non-disaster periods. The FRB system, on the other hand, is stable in the short-run because it then depends only on the probability of a significant number of customers demanding their specie thus bringing it down but unstable in the long-run because it causes the business cycle that will cause it to be incapable of fulfilling its obligations even if it were to sell all of its assets including financial "assets".

If you do not address Rothbard's argument that FRB causes the business cycle that in turn makes the FRB system unstable, you will have to be judged as evading the real argument.

On the other hand, the FRB system is unstable BECAUSE OF the way it conducts its business and not IN SPITE OF it. The causes of the failure of an insurance firm are EXOGENOUS to it while the causes of failure of the FRB system are ENDOGENOUS to it...

The cause of the failure of an insurance firm when a very large number of clients need insurance payments IS the ENDOGENOUS fact that they do not have enough money to pay all these contracts at the same time - just like a FRB.

"The cause of the failure of an insurance firm when a very large number of clients need insurance payments IS the ENDOGENOUS fact that they do not have enough money to pay all these contracts at the same time - just like a FRB."

FALSE again. The reason the insurance firm is suddenly unable to fulfill its obligations is a surge in claims which in turn is caused by a disaster over which the firm has no control could not have expected and hence could not have factored into its policies. It is hence EXOGENOUS.

On the other hand, an FRB system is suddenly unable to fulfill its obligations because it faces a surge in claims which in turn is caused not by factors over which it has no control but by factors which it CREATES. The business cycle, the bust of which results in the surge in claims on the FRB system, is a creation of the FRB system itself. It is hence ENDOGENOUS.

If you do not address Rothbard's argument that FRB causes the business cycle that in turn makes the FRB system unstable

A 100-reserve banking system could still make large numbers of bad loans that default, causing huge loss of savings, a demand contraction and a business cycle - Rothbard is wrong that the business cycle would disappear under his fanasty 100% reserve system.

And also: where in the world, ever, over the past 300 years can you point to an actual example of a 100% reserve banking system??When has this this non-existent, fantasy world ever existed??

Never. Why? Because free markets have led time and again to FRB. And there are plenty of instances where FRB arose without a central bank.

The reason the insurance firm is suddenly unable to fulfill its obligations is a surge in claims which in turn is caused by a disaster over which the firm has no control could not have expected and hence could not have factored into its policies.

The very same applies to FRB, idiot.

The reason the FRB is suddenly unable to fulfill its obligations is a surge in claims for money which in turn is caused by a EXOGENOUS FACTORS over which the firm has no control, could not have expected and hence could not have factored into its policies, like a change in subjective business expectaions causing a fall in investment and a recession, a mere rumour of bad debts not even true, a sudden need for money on a large part of its clients due to family death, accident, unemployment, unexpected bills etc.

"A 100-reserve banking system could still make large numbers of bad loans that default, causing huge loss of savings, a demand contraction and a business cycle - Rothbard is wrong that the business cycle would disappear under his fanasty 100% reserve system."

ROFLMFAO. Now you are refuting ABCT without explicitly saying so. What mendacity!!!

"Never. Why? Because free markets have led time and again to FRB. And there are plenty of instances where FRB arose without a central bank"

What a fanciful notion. It arose on the market, but it could not have survived without blatant government intervention in the form of suspension of the obligation to redeem notes and deposits in specie, sundry other restrictions on redemption and the institution of Central Banks at the later stages of the evolution of the FRB system.

"The reason the FRB is suddenly unable to fulfill its obligations is a surge in claims for money which in turn is caused by a EXOGENOUS FACTORS over which the firm has no control, could not have expected and hence could not have factored into its policies, like a change in subjective business expectaions causing a fall in investment and a recession"

No you retard!! ABCT explains why FRB has to result in the depression and the surge in claims. It can be anticipated and factored into the firm's policies. Hence, the insurance analogy is FALSE. The factors that bring about the downfall of an FRB system are indeed ENDOGENOUS.

Subjective expectations drive business confidence and business investment, because eocnomci lfe is a world of uncertainty. You could have a 100% reserve banking system and still have recessions and depressions.

The factors that could bring about the downfall of an FRB system are as exogenous as the factors that might cause an insurance company to fail.

You ignore the other explanation I mentioned that refutes you: factors such as a sudden need for money from a large part of a FR bank's clients due to family death, accident, unemployment, unexpected bills etc.which would bankrupt it.

"Subjective expectations drive business confidence and business investment, because eocnomci lfe is a world of uncertainty. You could have a 100% reserve banking system and still have recessions and depressions."

FALSE. Rothbard's explains very clearly that FRB CAUSES the business cycle. Any attempt to say that you could have a business cycle under 100% reserve banking and a free market in money is either a reflection of complete ignorance of ABCT or, like in your case, is a lie that only a whatever-Keynesian pathological liar can and will utter.

"The factors that could bring about the downfall of an FRB system are as exogenous as the factors that might cause an insurance company to fail."

Repeating the same lie does not make it true. FRB causes the business cycle which in turn causes the downfall of the FRB system. To call the factors exogenous is either utter idiocy or a barefaced lie. I know what it is in your case, you whatever-Keynesian pathological liar.

"You ignore the other explanation I mentioned that refutes you: factors such as a sudden need for money from a large part of a FR bank's clients due to family death, accident, unemployment, unexpected bills etc.which would bankrupt it"

Family death, accidents, unexpected deaths and unexpected bills may cause business failure of a few banks but not the business cycle which destabilises the ENTIRE FRB SYSTEM, you retard. Your "explanation", therefore is total balderdash. Unadulterated nonsense.

"Subjective expectations drive business confidence and business investment, because eocnomci lfe is a world of uncertainty. You could have a 100% reserve banking system and still have recessions and depressions."

Yeah!! And a sudden surge in "animal spirits" causes an investment boom that we call the boom phase of the business cycle. Even worse, a sudden inexplicable vanishing of these "animal spirits" and a general, causeless feeling of pessimism causes the bust phase of the business cycle. All put together, the causes of the business cycle are random, exogenous factors and inherent weaknesses in the free market itself. Where do you think I have heard this "explanation", you whatever-Keynesian pathological liar?

Yes, but what you didn't do is give 1 reason for why bank money is "money". LK tried and failed. Why don't you? Didn't you notice? I gave a minimal definition of money - a transferrable credit/debt relationship - that bank money fits. It being accepted for taxes makes it almost, but not quite, equivalent to state money.

Credit/state theories of money encompass all forms of money. Austrian/commodity/"medium of exchange arising through free markets" (without the dirty rotten government) money never existed. "Honest money" is a figment of the imagination; there is no historical evidence of it ever existing. The only kind that has ever existed is "funny money" -which has always been basically a creature of the state.

"Credit/state theories of money encompass all forms of money. Austrian/commodity/"medium of exchange arising through free markets" (without the dirty rotten government) money never existed. "Honest money" is a figment of the imagination; there is no historical evidence of it ever existing. The only kind that has ever existed is "funny money" -which has always been basically a creature of the state"

I just read Gene Callahan's article and you know what? I fully agree with him. The small but important point that you seem to have missed out is that Callahan's purpose is not to study the stability of FRB but to consider the validity of the call to prohibit it.

Unless, of course, you are talking of a different article, pitting Gene Callahan's against my argument is a serious case of barking up the wrong tree.

Once again, I fully agree with Gene Callahan and support even you in saying that FRB should not be prohibited. What you are failing to realise is that my argument is not the immorrality of FRB but its inherent instability that comes from endogenous factors unlike the insurance industry whose instability comes from exogenous factors.

"Rothbard's position is still basically a moral argument, pure and simple."

I'm sorry, but you don't have any idea on what you're talking about. Rothbard's main argument against fractional reserve banking is that it is inherently unstable. Have you ever read any of Rothbard's major works?

What's hilarious is1. Your notion that your statements have anything at all to do with economics2. That you consider your tall tales to be history3. Thirdly, with the kind of nonsense you hold to be knowledge, that you can find anything at all amusing

Bala - I understand the Austrian (hi)story of money. It is the mainstream story - believed even by Lord K here to some degree. What is not widely understood is how much all of mainstream "economics" depends on the foolish belief that money was ever, could ever fundamentally be a thing, a commodity, not a creditary relationship.

"My" tall tales are the ones supported by archeology, sociology, numismatics, anthropology and history. The Austrian story is supported by ... nothing. When archeology etc were in their infancy, maybe it was a reasonable guess - but now? - It just shows the extraordinary low scholarly standards of "economics".

"the foolish belief that money was ever, could ever fundamentally be a thing, a commodity, not a creditary relationship."

Firstly, even the statement that money is a creditary relationship is a "belief". You are just claiming that it is backed by a list of areas of study (don't want to call them sciences because they are not).

Secondly, I don't know if you realise that almost all the areas you cite are little more than story telling exercises. Archaeology digs up artifacts and spins them together into what the archaeologist or the historian studying those artifacts believes to be a credible story. History is itself a story-telling exercise. Numismatics too builds stories around available facts. Please convince me that your story-telling exercises are more credible than the story I hold more credible right now.

Thirdly, every story telling exercise has premises. Care to list out the premises that led you to the conclusion that money is, was and always has been a creditary relationship and not a commodity?

IMHO, the really crucial pillars of the modern banking system are the government machinery of taxation and the deposit insurance system. The former forces people into the banking system and the latter reduces the chance that they get out.

But Bala, you repeat yourself.

Deposit insurance has no hoard of gold and silver to back it, any more than the main banking system does. Ultimately only government force is backing the entire system, and generally that force will manifest as taxation (possibly hidden by inflation), or if things get really bad they will just change the rules.

Once more, we get back to the fundamentals of a protection racket, and the banks are merely part of that process. Since we appear to be debating the morality of honest transactions here, it seems reasonable to be upfront about the process -- the government sells protection, you buy the protection and sell labour, goods or whatever.

You are right that the government backing of private banks can encourage moral hazard - which is why banks - bank lending - bank money creation - should be strictly regulated. The current crisis is partly due to abandonment and nonenforcement of regulation.

What the Austrians and Libertarians are asking for is: [1] that banks keep a largish percentage of reserves in the form of precious metal or some solid and tangible commodity (say 25% would keep most of us happy), [2] that banks clearly declare their percentage of reserve, where it is held, how it is held, etc and [3] government provides some mechanism to allow some genuine choices in the market.

So if we rename our demands as a "strictly regulated" banking industry does that make our position more acceptable? We could even live without [1] because it is a natural consequence of [2] and [3]. Trouble is we are now living with bank regulations thick as a phonebook, poorly understood by anyone (even the regulators) and haphazardly enforced.

The Austrians are suggesting banking regulations that could be written on a postcard and understood by everyone and demanding that basic concepts (such as honest dealing) would be strictly enforced rather than a mile of esoteric frippery with no hope of enforcement.

The insurance industry - just like FRB - can be operated profitably over long periods and is stable.

Except for those short periods when something major goes wrong, and that's when you really need insurance.

But when some unforeseen disaster happens (a massive natural diaster) the insurance companies would be overwhelmed by claims and collapse, because they cannot pay.

And basic statistics says these situations will happen sooner or later. The longer you wait, the more that a "freak" event becomes an inevitable event.

Is that an even REMOTELY serious argument against insurance?

You question is not clear, if you are asking whether it is an argument against the customer taking out insurance at all, then certainly the possibility of a massive event that wipes out the insurance company is something the customer should be taking into consideration.

If you are asking whether we have an argument to remove the entire insurance industry, then that would be a straw man anyhow -- it is merely an argument for the insurance company to issue a clear statement about their own limitations and likelihood of bankruptcy in the case of a major disaster. In other words, just like a bank they should be forced to declare how deep their reserves are and what those reserves consist of... and just like any other business they should be forced to declare exactly what the product is that they are selling.

On what basis should banks and insurance companies (often one and the same) be treated differently to other businesses?

I see that you are well and truly lost in "The Lost Science of Money". Just downloaded it and started reading it, but just a quick glance at the first few pages reveals quite a few pieces of fallacious thinking. Just wanted to know if this "masterpiece" is what you treat as the basis of your "argument" and your "credible" stories.

@ 3:55 anon"You know, don't claim to have the support of history when you pick and choose what parts of history you want to consider. "

5-6 months ago i gave an example to him about Iraqis rejecting state money in favor of a spontaneous system of bottled water, cigarettes and goats. the answer i got was (and im paraphrasing, but i believe it to accurately reflect the answer) 'thats not how i define it, so it doesnt count'.

FRB causes the business cycle which in turn causes the downfall of the FRB system. To call the factors exogenous is either utter idiocy or a barefaced lie. I know what it is in your case, you whatever-Keynesian pathological liar.

Bala, I do wish you wouldn't get cranky and bring down the tone of an otherwise excellent discussion.

I think the words you are looking for are "positive feedback", as discussed by Paul Ormerod in his book "The Death of Economics". If you haven't read the book then I can heartily recommend it. I'll buy copies for people in this discussion who can provide some way for me to get postal details, and who are too poor or too cheap to get their own copy.

Can I also recommend Steve Keen's work on stability in a credit-driven economic system?

By the way, Steve Keen tends to be Keynesian about finding solutions to the problem (i.e. more government intervention, more money printing, and explicit debt forgiveness). I'd say he can be correct about his analysis that we do have a problem, but incorrect about his approach to a solution. For what it's worth, Keen considers Krugman to be a "Neoclassical" economist, but a good quality neoclassical (heart in the right place, just a bit deluded).

... the foolish belief that money was ever, could ever fundamentally be a thing, a commodity, not a creditary relationship.

Many thousands of years of history where people either bartered or exchanged gold and sliver (in coin or otherwise) would argue otherwise. Commodities work perfectly well as money, although in some circumstances creditary relationship can also work.

Let's consider the Australian Dollar. In the hands of an Australian citizen, it's got value as protection money so you can pay your tax with it. In the hands of a Chinaman, or an Indian, it has no value as protection money because they have no need of protection from the Australian government, and they have no obligation to pay Australian tax. However, the Chinaman and the Indian are both thinking about the coal, iron, zinc, gold, wheat, beef, lamb, sugar, etc they can buy with that AUD so the value it has in their hands is driven by commodities.

5-6 months ago i gave an example to him about Iraqis rejecting state money in favor of a spontaneous system of bottled water, cigarettes and goats. the answer i got was (and im paraphrasing, but i believe it to accurately reflect the answer) 'thats not how i define it, so it doesnt count'.

The early Australian economy used bottles of rum as money. Worked perfectly well, if you weren't bothered by the good citizens doing their duty to prevent inflation.

I've yet to see any certificate of fractional reserve rum cellaring!

Mind you, if you buy alcohol in Australia today, 90% of what you pay is tax, and you could very easily make the same stuff without the tax except that doing so happens to be illegal. So in essence, not much has changed in 200 years.

About Me

I teach economics at Frostburg State University in Frostburg, Maryland. We are located on the Allegheny Plateau, and we have cool summers and tough winters.
I am the single father of five children, four of them adopted from overseas and I have two grandchildren. My family and I are members of Faith Presbyterian Church (PCA).